Commentary and analysis on markets, personal finance, and wealth building from a contrarian perspective. "I believe in the discipline of mastering the best that other people have ever figured out. I don’t believe in just sitting there and trying to dream it up all yourself. Nobody’s that smart."
— Charlie Munger

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Wednesday, December 7, 2011

We've been down this path before

“What has been will be again, what has been done will be done again; there is nothing new under the sun.” Ecclesiastes 1:9

If, as an investor, you are looking at the U.S. and Europe, and are confused by the barrage of sombre news relating to economic issues - such as stubbornly high unemployment, collapsing housing prices, soaring government-debt levels, waning consumer confidence and a precarious banking system - I don’t blame you. As far as I can tell, so are the legions of experts, media and politicians, those we have traditionally trusted to explain such complex economic and financial matters to us. And why have all the herculean efforts to save us from these maladies failed so miserably, despite the fact that we seem to be drowning in remedies?

It seems as though America and Europe are going down for the count. As Canadians, we have a solid financial system and a stable government that functions as it was designed to do. And yes, we Canadians can take comfort that we are somewhat shielded from the profligate and irresponsible policies of our American and European friends, but given their sheer size and our inter-connectedness, we can’t completely escape the collateral damage when the stuff eventually hits the fan.

As the above Ecclesiastes quote (generally attributed to King Solomon) suggests, history is replete with examples of repetitive behaviour. Observing the behaviour of today’s policy-makers, I suspect this quote is as valid today as it was more than two millennia ago.

We are in an unholy mess and however loudly the sane few may plead, the chances it will get turned around without disaster striking are slim indeed. The type of restructuring both America and Europe need is so difficult and painful that, even if the current political systems were functioning, it would still take many years and the kind of courage and sacrifice that does not seem to exist. One of these days, some unforeseen event, akin to the child in Hans Christian Andersen’s The Emperor’s New Clothes declaring “But he isn’t wearing anything at all!” may serve as the tipping point that brings the entire financial system to its knees.

To get a proper understanding of the current situation, we should start by ignoring all the noise propagated by the experts, media and elected officials.

Our global financial system is based on the very simple and fragile concept of confidence. So you can’t really blame the policy-makers and politicians for not telling the public the “entire” truth; feeding us constant reassurances, peppered with a little mendacity. And to make things worse, it’s just human nature for us, the recipients of this information, to reject the idea that the worst can happen, hence our willingness to find reassurance in the misinformation we are fed. But folks, the worst CAN happen.

I doubt the citizens of Imperial Rome ever considered that their empire, which stretched from the Atlantic Ocean to the Caspian Sea, would eventually collapse on itself from the sheer weight of effort and resources needed to maintain it, or that 16th-century Spaniards ever thought their high standard of living, sustained by the plundered riches of the New World, would disintegrate once the supply of gold dwindled.

Or that the upper-class 19th-century Brits leading up to 1918 ever fathomed that the sun could cease to set on lands ruled by the British Empire. History has shown that when great nations mature and over-extend themselves, they revert to the paths of least resistance: borrow and/or print money. They all did it and they all failed; this time will be no different.

If Einstein’s definition of insanity - doing the same thing over and over again and expecting different results - holds true, we should move to have all of America’s and European policy-makers locked up in padded cells.

This hubris - holding on to time-worn ideas about what made a nation great in the first place, but ignoring the hard sacrifice that went with it - has prevailed throughout history and is as relevant today as it was for every great nation that came before America and the European Union.

Still, the “experts” continue to reassure us that America was built on a foundation of entrepreneurial spirit; we can get ourselves out of any mess. (At least the Europeans know better than to preach such fantasy.) I sense that some of those ideas don’t hold up as well as they once did, especially as the world outside of America has become highly competitive.

At some point in the evolution of a great nation must come a time when the simple math of mounting debt, lack of productivity and printed money plays havoc with ingrained beliefs. This is one of those times in history.

Therefore, as much as I would love to provide solutions to this mess-in-waiting, I would rather give some thoughts as to how to protect yourself.

Consider the following precaution as a condom for your portfolio or savings: protection against STDs (savings’ total destruction).

The bottom line is that the money needed to bail out Europe and to fund America’s spiralling debt and future unfunded obligations is in the tens of trillions. IT DOES NOT EXIST. It has to be created by printing money in massive quantities, and despite all the rhetoric you will hear against such policies, in the end it’s the path of least resistance. Printing money is an invisible tax on savings, much easier to initiate, than, say, raising taxes or cutting back on services and entitlements.

However, there is a lag on its negative effects, a perfect policy tool for elected officials who inevitably kick the can down the road to future governments. Policy-makers in most democracies live in a 24/7 campaign mode, which prevents them from making difficult, long-term and most certainly unpopular decisions. Simply said, we operate in a system not conducive to decisive action.

Witness last week’s dismal failure by the U.S. Congressional Super Committee to reach agreement after months of bitter negotiating on what was essentially a ridiculously minuscule reduction of the deficit over the next decade and you get the picture.

There will be a quantitative easing three (QE3) in the U.S. and the European Central Bank (ECB) will eventually follow suit in printing money in American-style amounts, despite Germany’s resistance to date.

If the world continues to print money, currencies will be debased against “tangible things” such as gold, farmland, exclusive real estate, rare art and collectibles, select equities to list a few. Therefore, having your savings invested in cash, bonds, money and markets, could mean a complete destruction of those savings by runaway monetary inflation.

Having said that, timing is an issue you must weigh carefully. There is a chance that another financial crisis such as we experienced in 2008 would cause the value of real assets to go down and, by definition, make cash holdings more valuable for a short period of time, until further “printing” reverses the trend once more.

I would recommend owning plenty of gold and, depending on your available resources, select real estate and collectible art, which works well for wealth preservation, and having an adequate pool of cash, which would only be used to acquire additional “real assets” in the event of another crisis.

It’s your wealth, your life savings; you are the only person who can protect it.

1 comment:

Anonymous
said...

You are confusing the economy with the stock market. Our economic system is based on fractional banking. Fractional banking demands ever expansion of the economy in order to service the debt and interest. Likewise with government debt. This allows for a great wealth expansion when people are employed and productive but is destined to fail when, as in Europe and the U.S. too great a portion of the population is unproductive and dependent on government transfers and pension payments. Confidence or lack of it can cause temporary ups and downs but the economy itself is based on basic economics not Happy Thoughts.